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Location: Kailua, Hawaii, United States

Peter Forman is the author of Wings of Paradise, Hawaii's Incomparable Airlines, a 400 page hardcover available online at www.airlinesofhawaii.com .

Friday, March 28, 2008





Aloha Airlines Bankruptcy, Questions and Answers

Q. How can Aloha Airlines survive this current cash crunch?
A. It needs to either merge with another airline or find a white knight with enough funding to carry it through the fare war which go! has initiated and sustained. Either long run solution should include a plan to upgrade the interisland fleet. In the short term, Aloha needs to find funding sources which will allow it to explore these options.

Q. Mesa’s figures for go!’s break-even costs differ substantially from the same figures provided by Aloha and other sources. Why?
A. Both the Sabre Study and statements by Aloha’s CEO’s assume typical load factors for each competitor. The Sabre Study calculates that planes would fly 62% full, because that was a close approximation to what was actually taking place. Figures supplied by Mesa’s CEO appear to be based either upon completely full airplanes or airplanes with unrealistically-high load factors. If Aloha used the same percentage of seats full to compute their costs, the longtime Hawaii airline would still retain a 20% to 30% cost advantage over go!.

Q. Shouldn’t our government stay out of the way and let competition determine who survives and who disappears?
A. In a properly-functioning free market, a company attracts customers by either offering a superior product or by being more efficient and offering the product at a lower price. The quality of Aloha’s product is certainly no less than the product offered by go!, as evidenced by go!’s inability to gain more than a small foothold in the market when Aloha and Hawaiian match fares. In terms of experienced pilots, comfort, on time arrivals, and schedule flexibility, Aloha’s product can be viewed as superior. Aloha’s cost structure has been 20%-30% below go!’s costs of offering the same product, according to the Sabre Study and recent comments from Aloha’s CEO. Thus, Aloha appears to be the superior competitor in a properly-functioning free market.

Unfortunately, Hawaii’s interisland market is anything but a properly-functioning free market. Mesa Air Group has sold its product well below its own cost of providing that product for the past year and a half. The free market model only works when companies actually seek profits. When one intentionally offers a product well below its cost, the competition becomes not survival of the fittest but instead survival of the wealthiest.

Q. Shouldn’t go! be subject to anti-trust prosecution, then?
A. Here we enter a grey area. The Airline Deregulation Act provided certain protections against prosecution for airlines which sell tickets below cost. A legitimate example of selling below cost includes sales during off-season to stimulate traffic, with the idea that the increase in travelers will more than compensate for the decrease in ticket price. Surely the architects of airline deregulation never envisioned the type of abuse which Mesa is currently employing, which is prolonged pricing at far below it’s break even point and the break even points of its competitors, as well.

At least two remedies are possible. First, Aloha could win a lawsuit against Mesa and establish a legal precedent which defines the limit of acceptable below-cost ticket sales in the airline business. If this solution is unsuccessful or cannot be accomplished quickly enough, the alternative is to refine the language in the Airline Deregulation Act so that legitimate below-cost pricing can continue but clearly anti-competitive abuse of this provision is prohibited.

Q. Has the U.S. government amended federal laws before because of abuse by an airline?
A. Yes, in the early 1980s Frank Lorenzo used federal bankruptcy laws to toss out the union contracts at Continental Airlines and slash pay in half. Such an abuse of the bankruptcy laws led to a revision of those laws which prohibited such actions unless the airline could persuade the judge that the contracts were a prime reason for the airline’s difficulties. A similar revision of laws may be warranted after a close examination of the Mesa vs. Aloha struggle.

Q. Couldn’t Hawaii just regulate airline fares within the state?
A. No. The federal government has deregulated airline pricing and does not allow states to overrule its methodology.

Q. What about asking the Justice Department to investigate this conflict?
A. That approach could be extremely important to Aloha’s survival. Mesa’s willingness to force prolonged losses is the 900 lb. gorilla in Aloha’s path to recovery. Defuse the fare war and 90% of Aloha’s troubles disappear. Suitors and lenders would respond appropriately.

Q. Aloha lost money after exiting bankruptcy and before go! entered the market. Isn’t this an indication that Aloha’s troubles are its own?
A. The amount of money Aloha lost prior to go!’s arrival was a manageable amount. Aloha’s new owners likely wanted to find a buyer for the airline and before tackling Aloha's weak point, which is its interisland fleet. Fleet changes are quite an expensive proposition, one to be avoided until the new owners are determined so that the fleet can match the purchasing airline’s fleet. Once go! entered the market with their $39, $29, $19, and $1 fares Aloha’s owners were stuck. No one but the largest airlines would want to take on Mesa with its “poison the waters” pricing, and the losses from the fare war with go! prevented Aloha from upgrading its interisland fleet to a more fuel-efficient type should Aloha wish to remain independent. Keep in mind that changing the interisland fleet affects not only the cost side of the equation but the revenue side, as well. Aloha’s load factors would increase if it introduced a newer interisland jet. This “new airplane” benefit to revenues is well-documented throughout the history of interisland flying. Unfortunately, go!’s fare war has prevented an interisland fleet upgrade by repelling potential suitors and by ensuring that Aloha does not have the cash needed to upgrade the fleet on its own. Since Aloha cannot shed its fuel inefficient fleet under the current pressure from Mesa, Mesa can be viewed as forcing Aloha to remain especially vulnerable to rising fuel costs.

Q. What about the rise in fuel costs? Isn’t that just as big a problem to Aloha as the go! fare war?
A. No. In a properly-functioning free market, airlines can raise their ticket prices to pass most of the fuel price increase to their customers. Not so in Hawaii’s interisland market, where go! is maintaining ticket prices that are well below the costs of all three competitors.

Q. Why are you so confident that Mesa intends to drive Aloha out of business?
A. For two reasons: Mesa’s words and its actions. When Hawaiian Airlines researched a recent lawsuit against Mesa, attorneys uncovered an email exchange between then-Mesa CFO Peter Murnane and Hawaii-based advisor Mo Garfinkle. Garfinkle stated that he believed Mesa’s go! Airlines would be unprofitable if Aloha remained in the market. Murnane responded that Mesa should enter the market anyway and give Aloha “the final push”. Emails between the two also indicated that Mesa planned to raise ticket prices once Aloha disappeared. These comments clearly indicate Mesa’s intentions in Hawaii, but its actions speak louder than words.

Let’s look at those actions. This past summer, during the busiest part of the travel season, Mesa unleashed $1 ticket sales at go!, and following this financial carnage with widespread sale of $19 tickets. Such sales make absolutely no economic sense any time of year, but especially during summer vacation. The fares were clearly designed to place the maximum financial burden possible upon go!’s competitors. Even go!’s $39 fares fell far short of the $67 which the Sabre Study indicated go! needed to charge if it wished to break even. Go! failed to test the waters and see how reasonable fares would be received by Hawaii’s traveling public. Go! surely would lose less money if it raised ticket prices, but it is reluctant to do so, because the airline wishes to provide the illusion that it can profitably offer these incredibly-low prices. If go! were to raise prices, it would lose less money in the interisland market. Since go! places punishing the competition as a higher priority than minimizing its own losses, it appears clear to me that go!’s actions accurately reflect its stated position of entering the market to give Aloha “the final push”.

Q. So, to wrap it all up, what must Aloha do to survive?
Short term financing is necessary, and a long-term owner or partner is needed to facilitate Aloha’s transition to an efficient interisland fleet. The biggest obstacle remains the interisland market’s unrealistically-low fares offered by go!. Should go! be forced or persuaded to discontinue this anti-competitive behavior, then Aloha’s chances of survival would improve dramatically. Perhaps we’ll see on March 31 what potential suitors are out there for Aloha. Stay tuned.

9 Comments:

Blogger Stan said...

Peter:

While it is unfortunate for Ron Burkle and the Yucaipa Cos. to pull their support for Aloha, it was almost predicted by the amount of blood that was flowing from the airline in 2007. Unlike the last time they filed, the situation has wholesale changed for Aloha. With go's stubborn presence in the market, and Jo Orenstein's unwillingness to let the idea of killing off Aloha go, Aloha itself must find a way to obtain a "white knight" to carry it through.

Who will be that white knight? Even the landscape for such a person has changed dramatically. With $100 a barrel oil and over $3 a gallon for fuel, possible purchasers are not playing on the field, but counting their reserves in an effort to ride out the recession of 2008.

My question that occurs is this - what else could Aloha do in whole to reduce costs? I know that Hawaiian basically shut down every extemporaneous part of the airline and outsourced it. Could Aloha save enough money by doing the same?

Another question - does the piecemeal sale of the airline basically decimates Aloha into a entity that is no longer viable? Yes, the sale of items such as the cargo ops and possibly the sale of the contract service ops would bring in money while scaling back the airline into a core passenger operator. But really, is that even going to be enough?

My fear, Peter, is that Aloha is basically going to go down a quicker version of what Pan Am did back in the 80's and 90's, sell everything off, only to be starved to death because there is nothing left to operate. Maybe that is the only road left, with the way things are.

I'd really hate to think that.

5:05 AM  
Blogger Peter Forman said...

Stan,
The absurdly-low fares in this market have indeed narrowed the possibilities of who the white knight can be. Only a large airline is likely to be willing to take on Mesa. I think that proposed state excise tax reductions are meant to make Aloha more attractive for another airline. I'm told that United recently backed out of a deal for Aloha, but if lawmakers sweeten the pot, who knows? Other airlines are wary of expansions while fuel prices are heading upwards, but a purchaser is not out of the question from this group.

If a suitable white knight is not announced on March 31, then Aloha needs to concentrate its efforts on the root cause of its demise: the predatory fares which go! is offering. I can think of three different scenarios for tackling the predatory fares issue: court injunction, refining the wording of the airline deregulation act, and a Department of Justice investigation. Of the three, the court injunction would be the quickest.

If Aloha can buy enough time, it may be able to rein in go!'s predatory fares through one of the above methods. If it is successful with this step, then the list of potential suitors will grow. Aloha needs to keep its eye on the root cause here.

As for selling off the parts, I agree that there's a real possibility of a Pan Am type scenario. A cargo unit which generates $6 million a year in profits is worth more than $13 million to a functioning Aloha Airlines.

6:45 PM  
Blogger Stan said...

Well, unfortunately a fourth scenario has emerged, and been acted upon...the airline is shutting down.

God save the employees of Aloha, and may God save the State of Hawaii...Sunday March 30 is indeed a dark day.

3:08 PM  
Blogger Stan said...

Peter:

I ran into a former employee of Aloha Airlines last night. His wife, a flight attendant, lost her job on the 1st when the airline went out of business.

One of the things he said struck me as very telling was the fact that if Hung Wo Ching and Sheridan Ing were still alive, this shutdown would have never happened. Needless to say, both of us agreed that Hung Wo and Sheridan's spirits are probably spinning in anger right now over this fiasco.

Knowing how Hung Wo would be, he would have either not hired Banmiller in the first place, or if Hung Wo was patient, thrown him out the second Banmiller suggested that the passenger ops needed to be shut down.

My question of the time is this....what does the heirs of Hung Wo and Sheridan thinking now? Did they do their fathers proud?

I personally wouldn't be.

2:14 PM  
Blogger Garry said...

Speaking as an old Mahalo Captain, I can't help but wonder how what go! did to Aloha compares to what Aloha did to Mahalo. Comments please.

5:36 AM  
Blogger Peter Forman said...

The demise of Mahalo is an interesting situation because it involves the turboprop vs. pure jet issue. The ATR-42s of Mahalo were efficient airplanes which could fly between the islands less-expensively than pure jets. The reality of the market, however, is that consumers prefer pure jets if the price is the same, and that the jet operators will match the prices of their competitors. So we have a situation where efficient turboprops could bring down the cost of inter-island flying but will likely not succeed in the major markets because the biggest competitors will match prices and consumers will prefer the pure jets.
Put another way, if all the inter-island airlines operated turbo-props, the cost of an inter-island ticket could drop, but if one of those competitors started operating a pure jet, market forces would necessity that all competitors fly pure jets or disappear.
I think there's an enormous difference between matching fares of a competitor such as Mahalo and slashing fares to unsustainable low levels, however.

10:08 AM  
Blogger Garry said...

Thanks Peter, but I'm not sure I agree about the demise of Mahalo. I don't think the turbo-prop vs pure jet issue was as much of a factor as you suggest. Mahalo was consistently trying to keep prices just below what Aloha and Island Air were charging. With those two lines forcing prices down with what must have been predatory intent, Mahalo didn't have access to deep enough pockets to hang on. Admittedly there were management problems and errors as well.

The demise of Mahalo was very unfortunate. Our regular passengers, especially from Molokai, loved us. The flight crew and station people were among the finest people I've ever worked with.

1:56 PM  
Blogger Peter Forman said...

Garry,
I'm sure Mahalo had plenty of fine employees and the ATR-42 is a capable and economical interisland aircraft. You argue, however, the Aloha was wrong in matching Mahalo's ticket prices. This is where we differ in opinion. It is true that Mahalo could have stabilized at a certain percentage of the market if its jet competitors allowed it to undercut their prices slightly. Why should the jet compeitors do this, however? It is quite expensive to shrink one's operation (retraining of crews, etc.) and allowing for a price differential is just handing a portion of the market to one's competitor. We'll probably never see eye to eye on this issue, but I think that defending one's market share by matching prices is reasonable business behavior while selling tickets at only a fraction of the cost of providing those seats for a year and a half is predatory behavior. Glad you enjoyed those years at Mahalo. I flew at Royal Hawaiian Air Service for two years and I treasure those memories.

2:22 PM  
Blogger abhi said...

If Aloha can buy enough time, it may be able to rein in goals predatory fares through one of the above methods..

abhi


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